Q. DIFFERENCE BETWEEN BILL OF EXCHANGE AND LETTER OF CREDIT (LC)

In brief, a "bill of exchange" or a "Hundi" is a kind of legal negotiable instrument used to settle a payment at a future date. It is drawn by a drawer on a drawee wherein drawee accepts the payment liability at a date stated in the instrument. The Drawer of the Bill of Exchange draw the bill on the drawee and send it to him for his acceptance. Once accepted by the drawee, it becomes a legitimate negotiable instrument in the financial market and a debt against the drawee. The drawer may, on acceptance, have the Bill of Exchange discounted from his bank for immediate payment to have his working capital funds. On due date, the bill is again presented to the drawee for the payment accepted by him, as stated therein the bill.

Letter of Credit (LC) is a declaration of financial soundness and commitment, by a bank for its client, for the amount stated in the LC document, to the other party (beneficiary) named therein. The LCs may or may not be endorse-able. In case of default of payment by the party under obligation to pay, the LC issuing Bank undertakes to honour the payment - with or without conditions. Normally, there may be sight LCs or DA LCs containing a set of conditions in both the cases. There "may be" Bills of Exchange(s) drawn under the overall limits of the LC amount for payment later on.

LETTER OF CREDIT – STANDBY VERSUS CONFIRMED LC:

LETTERS OF CREDIT- ADVISED vs. CONFIRMED

The letter of credit transaction usually involves two banks: the buyer's bank issuing the letter of credit and a bank in the seller's country, which advised the letter of credit to the beneficiary. The advising bank may also assume the role of confirming bank. Whether advising and/or confirming, the seller's bank assumescertain responsibilities.

Advising

An advising bank acts as the agent of the issuing bank. The function of the advising bank is to take reasonable care to verify the authenticity of credits received and then accurately transmit them to their beneficiaries. When advising a letter of credit, the bank assumes no other liability. On receipt of the documents for examination and payment, the advising bank will pay the seller only if it has received good funds from the issuing bank, even if it was specifically named as paying bank in the letter of credit.

Confirmation

By confirming a letter of credit, the advising or another bank

assumes the same responsibilities as the issuing bank, including the obligation to pay against presented documents if they are in order and all of the letter of credit terms are met. In effect, the beneficiary has the individual promise of two banks to pay against conforming documents; the issuing bank and the confirming bank.

How is a Letter of Credit Confirmed?

When negotiating the terms of sale, the seller would require a letter of credit requesting the advising bank to add its confirmation. The buyer includes this request when submitting the application for L/C issuance to his bank. In most instances the issued credit states: "Please advise beneficiary adding your confirmation" or words to similar effect. Note: This is a request, not a requirement. The advising bank for various reasons may decline to add its confirmation and simply advise the L/C without engagement onits part. When adding confirmation, typical language included in the cover letter would be, "We hereby confirm this credit and thereby undertake that all drafts drawn under, and in strict compliance with the terms stated therein (and any further terms stated herein) will be duly honored on presentation and delivery of documents as specified, if presented, at this office on or before the expiry date."

Why Request Confirmation?

The beneficiary may have concerns about the political or economic stability of the buyer's country, or the strength and reputation of the issuing bank. Confirmation by a bank known and convenient to the seller promotes the commercial utility of letters of credit. Also in the event of a dispute, jurisdiction will be determined by the confirming bank's location. THE PROBLEM / DISADVANTAGE IN LC CONFIRMATION IS THE LC PAYMENT BECOMES RESTRICTED AND THERE WILL BE UNNECESSARY CHARGES. SUCH AN LC IS MADE ONLY WHEN THERE IS DOUBT ABOUT GETTING THE PAYMENT.

What is a standby letter of credit?

A Standby Letter of Credit (called“SLC or “LC” ) are written obligations of an issuing bank to pay a sum of money to a beneficiary on behalf of their customer in the event that the customer does not pay the beneficiary. It is important to note that standby letters of credit apply only whenever the issuing bank's commitment to pay is not contingent on the existence, validity and enforceability of it’s customer’s obligation; this is called an “abstract” guarantee; that is, the bank’s obligation is to pay regardless of any disputes between its customer and the beneficiary. The issuance of letters of credit is a private transaction and does not result in the issuance of any public trading securities.

Why do we have standby letters of credit?

The standby letter of credit comes from the banking legislation of the United States, which forbids US credit institutions from assumingguarantee obligations of third parties. (Most other countries outside of the USA continue to allow bank guaruntees.) To circumvent this US banking rule, the US banks created the standby letter of credit, which is based on the uniform customs and practice for documentary credits. In 1998 the International Chamber of Commerce (ICC) added ISP98 (International Standby Practices 98) as the rules to guide standby letters of credit. These rules are slowly being adopted; however,many of the standby letters of credit continue to rely on the ICC’s older guide, Uniform Customs and Practices for Documentary Credits, 1993 revision, ICC Publication 500.

Who are the parties to the standby letter of credit?

(1) The Applicant. This is the customer of the bank who applies to the bank for the standby letter of credit. He must provide collateral to the bank or have sufficient credit to induce the bank to issue the instrument. He also must pay the bank a fee for issuing the instrument.

(2) The Issuing Bank. This is the applicant’s bank that issues the standby letter of credit.

(3) The Beneficiary. This is the party in whose favor the instrument is issued.

(4) Confirming Bank. This is a bank (usually located near the beneficiary) that agrees (confirms) to pay the beneficiary rather than have the issuing bank pay the beneficiary. The beneficiary pays the Confirming Bank a fee for this convenience. The Confirming Bank then collects from the Issuing Bank the amount paid to the beneficiary.

(5) Advising Bank. This is the bank that represents the beneficiary. It may accept the letter of credit on behalf of the beneficiary and collect on it on behalf of the beneficiary. In order for the transaction to be a bank-to-bank transaction, the advising bank works for the beneficiary to keep the instrument in the banking system. Sometimes the Advising Bank also is the Confirming Bank, but not always.

What is the purpose of the standby letter of credit?

The standby basically fulfills the same purpose as a bank guarantee: it is payable upon first demand and without objections or defenses on the basis of the underlying transaction between the applicant and the beneficiary. It is up to the beneficiary to decide whether he may accept a standby.

GLOSSARY OF LETTER OF CREDIT:

Acceptance Draft - payable at a fixed or determinable future date, upon the face of which the drawee has acknowledged in writing his or her

obligation to pay at maturity. See also "banker's acceptance" and "trade acceptance".

Account Party - The party instructing the bank to open a letter of credit and on whose behalf the bank agrees to make payment. In most cases, the account party is the importer/buyer, and is also known as the applicant.

Advice of Fate - Notification of the status of a collection that is still outstanding.When a draft bears this phrase, the time begins to run from its date. The date of maturity is therefore fixed and does not depend on the date of acceptance of the draft.

Advising Bank - A bank that accepts a letter of credit from the issuing bank, verifies its authenticity, and forwards it to the beneficiary. The advising bank does not take on any payment obligations.

After Sight - When a draft bears this phrase, the time begins to run from the date of its acceptance.

Air Waybill (of lading) - A signed receipt and a contract to deliver goods by air. Such bills are non-negotiable and do not convey title to the goods as do “To Order” bills of lading used by ocean and land carriers. The title passes to the party to whom the goods are consigned (the Consignee).

Amendment - Change to terms of a letter of credit. Beneficiary has the right to refuse the amendment under an irrevocable letter of credit.

Applicant - See "account party".

Assignment of Proceeds - A request by the beneficiary to pay all or part of the funds due to him to a third party. This instrument does not transfer rights in the letter of credit nor the title to the goods.

Back-to-Back Letter of Credit (L/C) - Letter of credit issued for the account of a buyer who is already holding an L/C in his or her favor. The back-to-back L/C is issued in favor of the supplier to cover the same shipment as stipulated in the credit already held by the buyer. Terms of both L/Cs, except for the amount and expiration date, are so similar that the same documents presented under the back-to-back credit are subsequently applied against the credit in favor of the buyer. However, the buyer/beneficiary of the first credit substitutes this draft and invoice for those presented by the supplier. See also “letter of credit”.

Banker’s Acceptance - Form of credit created when a bank “accepts” a time draft typically drawn on the bank by a seller of goods. By accepting a draft, the bank is obligated to pay the face amount at a specified time in the future, usually six months or less after acceptance. A seller of merchandise can sell the banker's acceptance for an amount less than face value and have immediate use of funds. See also “acceptance”.

Bank Draft - A check drawn by a bank on another bank payable to the seller at the request of the buyer. The check may be denominated in U.S. Dollars or most foreign currencies.

Beneficiary - The party who receives payment as stipulated in a letter of credit. This party is usually the seller/exporter.

Bill of Exchange - Formal written order addressed by one person (drawer) to another (drawee), signed by the drawer, and directing the drawee to pay on demand or at a fixed or determinable future time, a certain sum in money to the order of a specified person (payee).

Bill of Lading (Air, Ocean, Railroad, Truck) - A document of title issued by the carrier (transport company) or its agent. Bill of lading is a receipt for the merchandise in transit, as well as a contract for delivery to a specified party at a specified destination.

“BLANK ENDORSED” - A negotiable bill of lading in which the title to the merchandise is passed on to another party by means of an endorsement. The holder of the “blank endorsed” bill of lading is entitled to take possession of the merchandise.

“CLEAN BILL OF LADING” - One in which the goods are described as having been received by the carrier in “apparent good order and condition” and without qualification. “LATE PRESENTATION” (STALE): A bill of lading is presented to a bank for payment or negotiation after the stipulated date in the letter of credit, or later than 21 days after the date of its issuance.

“NEGOTIABLE OR ‘TO ORDER’” - A bill of lading in which the merchandise is consigned directly “to order” or “to the order of” a designated party, usually the shipper or a bank. The phrase “to order” or “to the order of (a designated party)” signifies negotiability permitting the title of the merchandise to be transferred many times by means of appropriate endorsements.

“NOTIFY” - This phrase requires the carrier to notify a designed party upon arrival of the merchandise, but does not transfer title of the merchandise to that party.

“STRAIGHT OR NON-NEGOTIABLE” - A bill of lading in which the merchandise is consigned directly to a designated party, generally the buyer, but

not to his “order”. Delivery of the merchandise is made only to the designated party, usually without surrendering the bill of lading.

“THROUGH” - A bill of lading issued by a shipping company or their agent covering more than one mode of transportation.

Cash Against Documents (CAD) - Payment for goods in which an intermediary (usually a bank) releases title documents to the buyer upon payment in cash.

Cash in Advance (CIA) - A term of trade in which the exporter does not ship goods until payment is received; offers the least risk to sellers and the most risk to buyers.

Clean Draft - A sight or time draft (bill of exchange) which is not accompanied by additional documents. Also referred to as "Clean Collection".

Collecting Bank - Bank that acts as an agent for a remitting bank that wishes to have its collections handled. The collecting bank demands payment from the buyer and handles the funds received as instructed; generally the funds are sent back to the remitting bank.

Commercial Invoice - A written and signed list of merchandise and/or services with associated quantities, prices and expenses. It contains the terms of the sale and is prepared by the seller to show the total amount owed by the buyer.

Confirmed Credit - A letter of credit in which the issuing bank’s obligation to pay is backed (confirmed) by a second bank.

Deferred Letter of Credit (L/C) - Letter of credit that calls for payment at a future date, but does not require a draft. See also “letter of credit” and “usance

letter of credit”.

Direct Collection - Method of payment for goods in which the seller sends a draft drawn on the buyer, the shipping documents, invoices, insurance certificates, other appropriate documents directly to the buyer’s bank for collection. Only an information copy of the advice is sent to the exporter’s bank to establish and monitor the collection transaction for the seller.

Discrepancy - Any deviation from the terms and conditions of a letter of credit or from the documents presented under the letter of credit.

Documentary Credit - A letter of credit issued to support the movement of merchandise supported by shipping documents presented by the beneficiary to the Issuing Bank for payment or acceptance.

Documents Against Acceptance (D/A) - Instructions given by a shipper to his or her acceptance bank that the documents attached to a time draft for collection are deliverable to the drawee/payer against his or her acceptance of the draft.

Documents Against Payment (D/P) - Instructions given by a shipper to his or her bank that the documents are deliverable to the drawee/payer only against his or her payment of the draft.

Draft - A draft is a formal demand for payment. It is an unconditional order in writing, addressed by one party (drawer) to another party (drawee), requiring the drawee to pay, at a designated or determinable future date, a specified sum in lawful currency (either in dollars or other currency) to the order of a named party (the Payee). In international trade, drafts are also known as “Bills of Exchange.”

Eurodollars - A term used for U.S. dollars held on deposit or traded anywhere else in the world except in the USA.

Eximbank (Export-Import Bank of the United States) - A U.S. government agency that offers insurance/guarantees of commercial or political risks associated with U.S. export transactions. These programs encourage U.S. exports by reducing the exporter’s risk.

Expiry or Expiration Date - The date on which the draft and documents drawn under a letter of credit must be presented to the negotiating, accepting, paying, or issuing bank in order to effect payment. The issuing bank’s obligation ceases on that date if the letter of credit is a “straight credit.” If the letter of credit is a “negotiable credit,” the issuing bank must honor the credit, provided the complying documents were submitted prior to the expiry (or expiration) date.

Foreign Exchange - The process of trading the currency of one country for that of another.

Foreign Exchange Exposure - A situation in which a U.S. company, selling/purchasing in a currency other than U.S. Dollars, runs the risk of receiving a reduced dollar amount or paying an increased dollar amount due to a fluctuating exchange rate.

Forward Transactions - Foreign exchange transactions settling between three business days and one year (and sometimes longer).

Freight Forwarder - An independent business that arranges for the shipment of export cargo and completes the necessary export documentation on behalf of the exporter.

Irrevocable Letter of Credit (L/C) - Letter of credit that cannot be changed or cancelled without the consent of all parties involved. Almost all L/Cs are irrevocable unless otherwise stated on L/C. See also “letter of credit”.

Issuing Bank - Bank that draws up and issues the letter of credit and that makes payment according to the conditions

Letter of Credit - An instrument issued by a bank, at the request of the applicant, promising to pay the beneficiary upon his presentation of stipulated documents in accordance with the terms and conditions of the credit.

“CONFIRMED”: A letter of credit issued by one bank to which another bank added its irrevocable confirmation to pay, thereby obligating itself in the same manner as the opening bank.

“STAND-BY”: A letter of credit that generally guarantees payment due for an unfulfilled obligation on the part of the applicant or another party. It is payable upon presentation of a draft, as well as a signed statement or certification by the beneficiary that the applicant has failed in his obligation.

Maturity Date - The date on which negotiable instruments become due for payment.

Negotiate - Take action to verify that the documents presented under an L/C conform to the requirements in order to release funds to the seller.

Negotiating Bank - The bank that reviews the documents required in the letter of credit for compliance with its terms and remits payment to the beneficiary. The bank may be specifically named in the letter of credit, or may be a bank

chosen by the seller.

Opening Bank - See "Issuing Bank".

Paying Bank - Bank that effects payment of documents negotiated under a letter of credit, customarily the buyer's bank. It is usually also the negotiating bank, unless the L/C allows another bank to negotiate or the paying bank is unable to negotiate. See also "negotiating bank".

Presentation - Presentation for acceptance or payment on a collection or letter of credit.

Proforma Invoice - An invoice sent in advance of shipment, to enable the buyer to obtain an import permit or exchange permit or both. The proforma invoice gives a close approximation of the weights and values of the intended shipment.

Protest - Legal process of demanding payment of a negotiable item from the maker who has refused to pay.

Red Clause - Clause in a letter of credit that authorizes the advising/negotiating bank to make an advance payment to the beneficiary before presentation of shipping documents, usually against a simple receipt.

Reimbursing Bank - The bank names in a letter of credit as the bank authorized by the issuing bank to honor claims presented by the paying, accepting, or negotiating bank.

Revocable Letter of Credit (L/C) - A letter of credit that can be modified or canceled by the issuing bank without the beneficiary’s consent unless the negotiation of complying documents has already taken place. The issuing bank must honor the draft(s) negotiated before the notice of revocation has been made.

Spot Transaction - Foreign exchange transaction in which foreign currency is bought at the current rate of exchange and delivered within two business days after the transaction date.

Spread - The difference between the buying (bid) rate and the selling (offer) rate of any foreign currency for any particular period.

Standby Letter of Credit (L/C) - Letter of credit issued to back an obligation of the applicant, but typically not intended to be the primary method of payment. Usually payable against drafts and statements, but not against commercial documents. See also “letter of credit”.

Trade Acceptance - Draft drawn by the seller of goods on the buyer and accepted by the buyer for payment at a specified future date. See also “acceptance”.

Transferable Letter of Credit (L/C) - Letter of credit that permits the beneficiary to transfer all or some of the rights and obligations under the credit to a second beneficiary. See also “letter of credit”.

UCP - Uniform Customs and Practices for Documentary Credits. Publication issued by the International Chamber of Commerce (2007 revision, ICC Publication No. 600, or “UCP 600”) that outlines the rules and guidelines involved in a letter of credit transaction.

Usance (Time) Credit - Letter of credit that calls for payment against drafts calling for payment at some specified date in the future. Gives buyers time to sell the goods to get the funds to reimburse the issuer.

Usance Letter of Credit (L/C) - Letter of credit that calls for payment at a

future date -- generally within six months -- and requires a draft drawn on the issuing/paying bank for the amount of the invoice. See also “letter of credit”.

Value (Settlement) Date - Contracted date on which the foreign exchange is to be delivered or received.

Letters of credit can be divided into two major types. They are:Standby Letters of Credit - Which act as a guarantee from a third party bank in the event of non-payment on the part of the creditor.

and...

Documentary Letters of Credit - Which are typically used by importers and exporters to transact business between companies in foreign countries.

BUYING AND SELLING GOODS INTERNATIONALLY

International sales transactions between sellers and buyers require an agreement as to the form of payment for the goods. Various methods of payment settlement include but are not limited to open account, foreign collection, cash in advance and documentary credit. One of the most common forms of payment is documentary credit, which is also known as a Letter of Credit.

What is a Letter of Credit?

A Letter of Credit is literally a "letter" pertaining to a sales transaction between a buyer and seller. The "letter" is initiated by the buyer and is directed to the seller or beneficiary, in most cases. In some cases, the beneficiary may not necessarily be the Seller but would be the party possessing the right to receive payment for the goods or services. (Please refer to the webpage dealing with transferable letters of credit for additional information.)

A Letter of Credit is the traditional worldwide risk management tool for international transactions. Issued by a foreign bank (representing the buyer) and confirmed by a corresponding bank usually in the country of the seller, a Letter of Credit is the overseas bank's commitment to pay the seller's drafts. A Letter of Credit is opened by an issuing or opening bank. The buyer

chooses the opening bank.

Revocable vs. Irrevocable Letters of Credit

A Letter of Credit may be revocable or irrevocable. In a revocable Letter of Credit, the issuing bank (representing the buyer) has the right to cancel or alter its obligation at any time before payment of a sight draft or acceptance of a time draft. That situation exists even if goods were shipped in reliance on the expectation of payment.

An irrevocable Letter of Credit that is accepted by the seller, however, cannot be altered or canceled without the consent of the seller. Any change to an irrevocable Letter of Credit requires the consent of all parties. Consent would include any parties beyond the buyer and seller. For example the confirming banks would be affected parties.

Confirmed vs. Unconfirmed

An irrevocable Letter of Credit can be either confirmed or unconfirmed.

In a confirmed Letter of Credit, the issuing bank (representing the buyer) agrees independently to the buyer's commitments to pay the seller the agreed-up amount of money, as long as all the

requirements of the Letter of Credit are fulfilled.

A confirmed irrevocable Letter of Credit can become very elaborate. A second bank (often specified as a prime bank) may confirm or otherwise guarantee payment of the foreign bank that

initially opened the Letter of Credit. This requirement originates from the seller and usually takes places only if the bank of the buyer is not internationally established.

Other types of Letters of Credit

Other types of Letters of Credit may include straight or negotiation credits. These types of Letters of Credit inform the seller whether any bank, or only certain banks, can process the documents of the seller to receive payment. All of the various types of Letters of Credit can be combined in various ways with extended rights and/or obligations, depending upon the exact type of Letter of Credit issued. A Seller should be aware of rights under a Letter of Credit before proceeding with a sale.

Letter of Credit rules- International Chamber of Commerse

A Standard Documentary Credit Application Form has been developed by the International Chamber of Commerce (ICC), in Paris, France. The ICC has also published a guide to Documentary Credit Operations. Banks throughout the world adhere to the rules developed by the ICC.

The rights and obligations of buyers, sellers and participating banks in international Letters of Credit transactions are presented in careful detail in publications made available by the ICC. Under the Uniform Customs and Practices for Document Credits (UCP), the International Chamber of Commerce has made available in a publication called the UCP 600. The publication is almost always referred to in international Letter of Credit forms and is a part of the Letter of Credit contract. The ICC also has available ICC Publication No. 511, which takes the reader through UCP 600 on an article-by-article and clause-by-clause basis. The ICC Publication No. 511 also explains the reasoning that led the ICC Working Group to develop a thoroughly revised sets of Rules for Documentary Credits under UCP 600.

Benefits of using a Letter of Credit

By conducting export sales transactions under an irrevocable Letters of Credit, the seller does not have to determine the credit standing of the foreign buyer. Letters of Credit are issued in many different forms from foreign banks and financial institutions. The variations are due to differences in customs and regulations of trade and finance in the country of origin of the issuing bank or financial institution. If, for any reason, a seller cannot comply with one or more conditions of a Letter of Credit, it is absolutely imperative for the seller to contact the buyer to arrange for one or more amendments to the original agreement.

Letter of Credit Discrepancies

If there is a disagreement between a sale contract's shipping and documentation requirements and those in a Letter of Credit, the seller must take immediate action before shipping to arrange

for an amendment to the Letter of Credit. If the seller does not arrange for such an amendment, the seller may experience payment problems. Full compliance with all conditions for

payment are interpreted by banks rigidly. Any disagreement, however small, represents grounds to reject the payment of the draft.

On a worldwide basis, approximately 60% of document presentations on Letters of Credit are presented with discrepancies. Banks charge for EACH discrepancy. Therefore, it is extremely important to ensure document presentations are accurate and complete to avoid additional costs and delays in payment processing.

Payment on a Letter of Credit

The documents listed in a Letter of Credit are presented to the negotiating/paying Bank with a draft, which is sometimes referred to as a "bill of exchange". A draft resembles a check. In a Letter of Credit sale, the drawee on the draft is the bank that issued the Letter of Credit. The seller is the drawer of the draft.

Drafts are classified as either sight or time. A sight draft requires

a drawee to pay the amount shown in full upon proper presentation of documentation. On a time draft, a payment date later than the date of presentation would be stipulated (such as 60 days after sight or 90 days after sight).

When properly presented, a time draft is accepted by the drawee. This means the drawee indicates an acknowledgement that the necessary conditions to its payment were met and the drawee is obligated to pay on the appointed date.

Paying a sight draft or accepting a time draft when documents or

goods have been presented is known as honoring the draft.

If the Letter of Credit states "payment at sight", the seller should receive payment within a reasonable time (usually not exceeding

seven days) after documents are presented within the validity period of the Letter of Credit and accepted by the negotiating (paying) bank.

Usual Letter of Credit conditions

The usual conditions included in a Letter of Credit include delivery dates, product specifications and receipt by the bank of specific documents (such as negotiable bills of lading, inspection

certificates, commercial invoices and packing lists). Any required

documents must be presented to the bank within a specific period of time. There may also be other terms and conditions as negotiated between the buyer and seller.

Letter of Credit terms and conditions (and all required documents) should be agreed upon between the buyer and seller, in advance of opening of a Letter of Credit. Letter of Credit issuance instructions should then conform to the terms of such an agreement.

Exporters in the United States should request the overseas buyer to open an Irrevocable Commercial Letter of Credit, payable 100% at sight, freely negotiable or confirmed by a bank.

If the Letter of Credit is to be confirmed, the seller should also request the buyer to instruct the issuing bank to obtain the Letter of Credit confirmed by a bank in the United States.